‘Inflation could be 7% by Mar-end’
The Financial Express, December 28, 2009, Page 1
MK VENU, KG Narendranath
Prime Minister’s Economic Advisory Council chairman C Rangarajan has spoken to FE on a range of macro-economic issues — from money supply growth to the need for concerted inflation management by the government and the central bank. He expressed the hope that Budget 2010 would maintain “adequate level of fiscal stimulus” for 8%-plus growth, but said fiscal deficit in 2010-11 should be brought below this year’s estimated 6.8%. He urged RBI and Sebi to take leadership in making financial markets deeper and diverse, particularly with robust debt instruments. Rangarajan also saw the government taking decisive action to pare the subsidy bills.
You have advised RBI to take monetary policy action in the wake of the nearly 20% food inflation which, it is feared, is already beginning to cause a generalised inflationary tendency.
What I have said is that, to reduce liquidity, RBI might need to raise the cash reserve ratio (CRR) after observing the price behavior till December-end. It could later consider the need for raising the other policy rates as well, depending on the situation. Usually, a new year brings about some seasonal decline in food prices.
Of course, in a situation like this, the primary action should be on the supply side. An effort must be made through appropriate policy action to increase the availability of food and bolster the distribution system.
At the same time, there is a need to ensure that the aggregate monetary demand is not excessive. We should not let money supply abet price increase. So, while I give the primary role in inflation management to the supply-side measures, it is important that the aggregate monetary demand is kept under some control. Some increase in CRR might be warranted, both as a signal and as a measure to reduce liquidity in the system.
The rate of growth of money supply has been high in the last several years. In the last three years, money supply increased by more than 20%. To some extent, the Market Stabilisation Scheme operations have played a role in managing liquidity, sometimes by draining it, but also by injecting liquidity when needed.
Despite these measures, there has been a substantial overall increase in money supply in the last four or five years. This year’s RBI target for money supply growth is 17%. But I think it is running at a level slightly higher than that rate. Therefore, some action by way of the adjustment of the CRR seems warranted.
Even if prices remain at current levels, the average inflation for January and February could be as high as 7.5% and 8.1%, respectively, on account of the base effect. How does this concern the policymakers?
It is true that the year-on-year inflation will keep increasing because of the base effect. However, the build-up of inflation from the end of March this year has already exceeded 7.5%. Therefore, unless there is some decline in prices by December, the overall inflation by March 2010 would be over 7%. The point is that if for any reason the index does not increase, it could be 7%.
Emerging economies like India would continue to face the prospect of huge capital inflows in the medium-term given the likelihood high growth. Isn’t there a need for a more stable policy to address capital inflows?
We had examined this (the issues concerning capital inflows) in our October outlook. Capital flows are now at comfortable levels and we do need them to bolster growth. We had estimated that gross inflow could be around $55 billion this fiscal, which means after financing the current account deficit of some $25 billion, there will be net addition to RBI’s foreign exchange reserves to the tune of $30 billion. We think that estimate would still hold true.
At the current levels, capital influx would not pose any serious problem to the monetary authority. Of course, it would have an impact on the exchange rate, but a $30 billion net addition to the RBI reserves is reckoned to be manageable.
You may recall that the rupee depreciated to very large extent last year, so a bit of correction, that is, some degree of appreciation, is not unacceptable. Real effective exchange rate is slightly above 100% now. It would possibly remain at that level. The capital flows would not put any extraordinary pressure on the rupee.
Don’t you see the need for greater coordination between fiscal and monetary authorities to make it easier for central bank to control inflation? What are the reform-related measures that the government must take to help RBI in inflation management?
For the monetary authority to manage the situation better, the fisc should not be too loose. In the coming year, an effort must be made to move towards the process of fiscal consolidation. It is necessary to reduce the fiscal deficit from 6.8% of GDP (the budget estimate for this year) to a lower figure. Some expenditure heads which were special to this year like payment of Pay Commission arrears to public sector employees would not be there next year.
The government will also have to take a call on how to deal with subsidies. There has been some moderation in crude oil prices over the past year and so the subsidy bill be lower than last year’s but would still be at a high level. I think it (subsidy management) is an issue attracting the attention of the government. Some steps need to be taken urgently to curtail the subsidy.
There is a view that food inflation sometimes exerts a disproportionate impact on other policy-making functions. A key problem is the profiteering on the part of the intermediaries as is evident from the fact that urban retail prices of unprocessed food items are up to 6 times the prices at the wholesale mandi level.
In the case of commodities that are procured by the government, the problem of intermediaries reaping unreasonable profits is less as farmers get the support price. This is not only true of cereals, pulses, sugar and oil, but also of perishables. In the case of other commodities, there is, of course, a substantial difference between what the farmers get and what the consumers have to pay.
Therefore, the medium-term policy focus should be on improving the distribution system with respect to the food items. Major retailers should go to the village and buy goods directly from farmers. In the case of perishables, there is a need to build the appropriate supply chains. Cold storages are extremely critical. Big private retailers could take the initiative and set up these chains, as most producers (small farmers) would find it difficult.
Producers’ cooperatives can also play a meaningful role in strengthening the distribution network for perishable agriculture commodities.
The proposed Goods & Services Tax (GST) is expected to reduce costs of businesses.
GST must primarily be seen as a better tax collection system. It is doubtless a good substitute for the existing system of excise duties and multiple local taxes. If we widen the tax base to include almost all commodities and services, the rate of tax would indeed come down.
Currently, only selectservices are taxed. It is important to have good (comprehensive) definition of services for taxation purpose.
The finance minister has underlined the need for the fiscal stimuli to run through the economy before they are withdrawn. Do you think the Budget 2009 would roll back part of the stimuli -- at least in terms of reversing the tax cuts?
The Budget 2010, I hope, would maintain adequate stimulus for the higher level of growth (8% plus) next year. In my view, one key aspect that needs to be watched of the Budget is how it would spell out the plan to bring about a reduction in fiscal deficit as part of a medium-term fiscal correction exercise. Clearly, the deficit of the kind that we’re now having is not sustainable as its persistence would exacerbate the debt-to-GDP ratio. Interest payments as proportion of the GDP could also start rising.
Perhaps, we would not be able to go back to the original FRBM path early enough. It could take some years. But despite that, we need to have a responsible medium-term strategy.
I’ve already mentioned about the action need to be taken on the subsidy front. Next year would also see a relative lessening of the onus on the fisc, with the absence of any special expenditure items like pay commission backlogs.
Tax reform is a potent instrument for tightening the fisc. I think Budget 2010 would not directly address the Direct Tax Code as more discussions are needed on this radical reform over the next year.
As for the GST, expectations are that if not at the beginning of the next fiscal year, it would be introduced at least towards the end of the year. In any case, this new indirect tax system would not be delayed beyond April 2011.
In your October review, you said the GDP growth this fiscal would be 6.5%. However, of late, there has been more optimistic estimate from the government.
The overall GDP growth rate this fiscal could be around 7% or, perhaps, a little more than 7%.
What is your forecast of inflation in 2010-11?
It is reasonable to assume that inflation would come down next year. Year-on-year inflation (wholesale price index) measured on a monthly basis could come down to around 5% by the end of next year. Growth rate would be stronger next year which would also witness a revival of agriculture and a consequent decline in food prices.
However, a significant risk factor is the uncertainty over the global crude oil prices. A surge in global commodity prices can adversely impact India. Thankfully, there is hardly any forecast of a major spurt in oil prices in 2010-11, as the developed economies that are coming out of the recession, would at best have a very-low-positive growth rate, 1-2% or so.
You have repeatedly emphasized the importance of accelerating the rate of growth power generation. Would the 11 th Plan capacity addition target for the electricity sector be met?
For the first two years of the Plan, shortfalls were reported. It is likely that there would be a shortfall in the third year (the current year) also. So, we would need to organize ourselves to make up for the shortfalls and meet the target, with the capacities to be created in the last two years of the Plan period.
I’m happy to note that certain initiatives have already been made in this direction. One of the constraints has been the inadequate (and delayed) supply of generation equipment. BHEL has already enhanced its capacities, so have a few private players too. Excessive reliance on imported equipment is not desirable. We need to ensure, through appropriate policy action, that the domestic availability of power generation equipment is substantially enhanced.
Why does the government keep a low pace when it comes to financial sector reforms?
Legislative action is already underway in this regard with the pension, insurance and banking bills being tabled in Parliament. These bills must be quickly passed.
Simultaneously, there is a need for regulatory initiatives to improve the efficacy of the financial sector in its totality. We need to create new products and new markets. In the industrially advanced economies, debt markets are well-developed. We need to have robust debt market to facilitate the flow of credit to medium and small industries. Either RBI or Sebi should take the leadership role in developing the debt markets.
The Financial Express, December 28, 2009, Page 1
MK VENU, KG Narendranath
Prime Minister’s Economic Advisory Council chairman C Rangarajan has spoken to FE on a range of macro-economic issues — from money supply growth to the need for concerted inflation management by the government and the central bank. He expressed the hope that Budget 2010 would maintain “adequate level of fiscal stimulus” for 8%-plus growth, but said fiscal deficit in 2010-11 should be brought below this year’s estimated 6.8%. He urged RBI and Sebi to take leadership in making financial markets deeper and diverse, particularly with robust debt instruments. Rangarajan also saw the government taking decisive action to pare the subsidy bills.
You have advised RBI to take monetary policy action in the wake of the nearly 20% food inflation which, it is feared, is already beginning to cause a generalised inflationary tendency.
What I have said is that, to reduce liquidity, RBI might need to raise the cash reserve ratio (CRR) after observing the price behavior till December-end. It could later consider the need for raising the other policy rates as well, depending on the situation. Usually, a new year brings about some seasonal decline in food prices.
Of course, in a situation like this, the primary action should be on the supply side. An effort must be made through appropriate policy action to increase the availability of food and bolster the distribution system.
At the same time, there is a need to ensure that the aggregate monetary demand is not excessive. We should not let money supply abet price increase. So, while I give the primary role in inflation management to the supply-side measures, it is important that the aggregate monetary demand is kept under some control. Some increase in CRR might be warranted, both as a signal and as a measure to reduce liquidity in the system.
The rate of growth of money supply has been high in the last several years. In the last three years, money supply increased by more than 20%. To some extent, the Market Stabilisation Scheme operations have played a role in managing liquidity, sometimes by draining it, but also by injecting liquidity when needed.
Despite these measures, there has been a substantial overall increase in money supply in the last four or five years. This year’s RBI target for money supply growth is 17%. But I think it is running at a level slightly higher than that rate. Therefore, some action by way of the adjustment of the CRR seems warranted.
Even if prices remain at current levels, the average inflation for January and February could be as high as 7.5% and 8.1%, respectively, on account of the base effect. How does this concern the policymakers?
It is true that the year-on-year inflation will keep increasing because of the base effect. However, the build-up of inflation from the end of March this year has already exceeded 7.5%. Therefore, unless there is some decline in prices by December, the overall inflation by March 2010 would be over 7%. The point is that if for any reason the index does not increase, it could be 7%.
Emerging economies like India would continue to face the prospect of huge capital inflows in the medium-term given the likelihood high growth. Isn’t there a need for a more stable policy to address capital inflows?
We had examined this (the issues concerning capital inflows) in our October outlook. Capital flows are now at comfortable levels and we do need them to bolster growth. We had estimated that gross inflow could be around $55 billion this fiscal, which means after financing the current account deficit of some $25 billion, there will be net addition to RBI’s foreign exchange reserves to the tune of $30 billion. We think that estimate would still hold true.
At the current levels, capital influx would not pose any serious problem to the monetary authority. Of course, it would have an impact on the exchange rate, but a $30 billion net addition to the RBI reserves is reckoned to be manageable.
You may recall that the rupee depreciated to very large extent last year, so a bit of correction, that is, some degree of appreciation, is not unacceptable. Real effective exchange rate is slightly above 100% now. It would possibly remain at that level. The capital flows would not put any extraordinary pressure on the rupee.
Don’t you see the need for greater coordination between fiscal and monetary authorities to make it easier for central bank to control inflation? What are the reform-related measures that the government must take to help RBI in inflation management?
For the monetary authority to manage the situation better, the fisc should not be too loose. In the coming year, an effort must be made to move towards the process of fiscal consolidation. It is necessary to reduce the fiscal deficit from 6.8% of GDP (the budget estimate for this year) to a lower figure. Some expenditure heads which were special to this year like payment of Pay Commission arrears to public sector employees would not be there next year.
The government will also have to take a call on how to deal with subsidies. There has been some moderation in crude oil prices over the past year and so the subsidy bill be lower than last year’s but would still be at a high level. I think it (subsidy management) is an issue attracting the attention of the government. Some steps need to be taken urgently to curtail the subsidy.
There is a view that food inflation sometimes exerts a disproportionate impact on other policy-making functions. A key problem is the profiteering on the part of the intermediaries as is evident from the fact that urban retail prices of unprocessed food items are up to 6 times the prices at the wholesale mandi level.
In the case of commodities that are procured by the government, the problem of intermediaries reaping unreasonable profits is less as farmers get the support price. This is not only true of cereals, pulses, sugar and oil, but also of perishables. In the case of other commodities, there is, of course, a substantial difference between what the farmers get and what the consumers have to pay.
Therefore, the medium-term policy focus should be on improving the distribution system with respect to the food items. Major retailers should go to the village and buy goods directly from farmers. In the case of perishables, there is a need to build the appropriate supply chains. Cold storages are extremely critical. Big private retailers could take the initiative and set up these chains, as most producers (small farmers) would find it difficult.
Producers’ cooperatives can also play a meaningful role in strengthening the distribution network for perishable agriculture commodities.
The proposed Goods & Services Tax (GST) is expected to reduce costs of businesses.
GST must primarily be seen as a better tax collection system. It is doubtless a good substitute for the existing system of excise duties and multiple local taxes. If we widen the tax base to include almost all commodities and services, the rate of tax would indeed come down.
Currently, only selectservices are taxed. It is important to have good (comprehensive) definition of services for taxation purpose.
The finance minister has underlined the need for the fiscal stimuli to run through the economy before they are withdrawn. Do you think the Budget 2009 would roll back part of the stimuli -- at least in terms of reversing the tax cuts?
The Budget 2010, I hope, would maintain adequate stimulus for the higher level of growth (8% plus) next year. In my view, one key aspect that needs to be watched of the Budget is how it would spell out the plan to bring about a reduction in fiscal deficit as part of a medium-term fiscal correction exercise. Clearly, the deficit of the kind that we’re now having is not sustainable as its persistence would exacerbate the debt-to-GDP ratio. Interest payments as proportion of the GDP could also start rising.
Perhaps, we would not be able to go back to the original FRBM path early enough. It could take some years. But despite that, we need to have a responsible medium-term strategy.
I’ve already mentioned about the action need to be taken on the subsidy front. Next year would also see a relative lessening of the onus on the fisc, with the absence of any special expenditure items like pay commission backlogs.
Tax reform is a potent instrument for tightening the fisc. I think Budget 2010 would not directly address the Direct Tax Code as more discussions are needed on this radical reform over the next year.
As for the GST, expectations are that if not at the beginning of the next fiscal year, it would be introduced at least towards the end of the year. In any case, this new indirect tax system would not be delayed beyond April 2011.
In your October review, you said the GDP growth this fiscal would be 6.5%. However, of late, there has been more optimistic estimate from the government.
The overall GDP growth rate this fiscal could be around 7% or, perhaps, a little more than 7%.
What is your forecast of inflation in 2010-11?
It is reasonable to assume that inflation would come down next year. Year-on-year inflation (wholesale price index) measured on a monthly basis could come down to around 5% by the end of next year. Growth rate would be stronger next year which would also witness a revival of agriculture and a consequent decline in food prices.
However, a significant risk factor is the uncertainty over the global crude oil prices. A surge in global commodity prices can adversely impact India. Thankfully, there is hardly any forecast of a major spurt in oil prices in 2010-11, as the developed economies that are coming out of the recession, would at best have a very-low-positive growth rate, 1-2% or so.
You have repeatedly emphasized the importance of accelerating the rate of growth power generation. Would the 11 th Plan capacity addition target for the electricity sector be met?
For the first two years of the Plan, shortfalls were reported. It is likely that there would be a shortfall in the third year (the current year) also. So, we would need to organize ourselves to make up for the shortfalls and meet the target, with the capacities to be created in the last two years of the Plan period.
I’m happy to note that certain initiatives have already been made in this direction. One of the constraints has been the inadequate (and delayed) supply of generation equipment. BHEL has already enhanced its capacities, so have a few private players too. Excessive reliance on imported equipment is not desirable. We need to ensure, through appropriate policy action, that the domestic availability of power generation equipment is substantially enhanced.
Why does the government keep a low pace when it comes to financial sector reforms?
Legislative action is already underway in this regard with the pension, insurance and banking bills being tabled in Parliament. These bills must be quickly passed.
Simultaneously, there is a need for regulatory initiatives to improve the efficacy of the financial sector in its totality. We need to create new products and new markets. In the industrially advanced economies, debt markets are well-developed. We need to have robust debt market to facilitate the flow of credit to medium and small industries. Either RBI or Sebi should take the leadership role in developing the debt markets.
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